Bills of Exchange and Promissory Notes

1. Definition and Key Features

Bills of Exchange and Promissory Notes are essential instruments used in trade and accounting for the settlement of debts.

Bills of Exchange

A Bill of Exchange is a negotiable instrument in writing, containing an unconditional order, directing one person to pay a certain sum of money to another person or their order, at a future date.

Parties Involved:
- Drawer: The person who writes and issues the bill (the creditor).
- Drawee: The person on whom the bill is drawn (the debtor).
- Payee: The person to whom the payment is to be made, which can be the drawer or a third party.
Key Features:
1. Unconditional Order: The drawer directs the drawee to pay a certain sum without any conditions.
2. Payable on Demand or Future Date: It can be payable immediately or after a specified time.
3. Transferability: Bills of exchange are negotiable instruments, meaning they can be transferred to another party.

Example: A supplier (drawer) sends a bill of exchange to a buyer (drawee), asking for payment after 60 days.

Promissory Note

A Promissory Note is a written and signed document where one party (the maker) promises to pay a certain sum of money to another party (the payee) either on demand or at a future date.

Parties Involved:
- Maker: The person who promises to pay the money (the debtor).
- Payee: The person who receives the money (the creditor).
Key Features:
1. Written Promise: It contains an unconditional promise by the maker to pay a fixed amount.
2. No Third Party: In contrast to bills of exchange, there are only two parties involved.
3. Fixed Date of Payment: The promissory note specifies when the payment is to be made (either on demand or at a later date).

Example: A borrower (maker) gives a promissory note to a lender (payee), promising to repay the loan amount after 90 days.

Differences Between Bill of Exchange and Promissory Note

Aspect	Bill of Exchange	Promissory Note
Number of Parties	Involves three parties: Drawer, Drawee, Payee	Involves two parties: Maker, Payee
Nature	An order to pay	A promise to pay
Drawee's Acceptance	Requires acceptance by the drawee	No acceptance is needed by the payee
Liability	Drawer is contingently liable	Maker is primarily liable
Type of Instrument	Negotiable by endorsement	Can also be endorsed but involves fewer parties

Accounting Treatment

1. Bills of Exchange:

At the Time of Drawing the Bill:
- Drawer's Entry:
  - Debtor's Account Dr.
  - To Bills Receivable Account
- Drawee's Entry:
  - Bills Payable Account Dr.
  - To Creditor's Account
On Maturity (Payment):
- Drawer's Entry:
  - Cash/Bank Account Dr.
  - To Bills Receivable Account
- Drawee's Entry:
  - Bills Payable Account Dr.
  - To Cash/Bank Account
If the Bill is Discounted (when the drawer sells the bill to a bank before its maturity):
- Drawer's Entry:
  - Bank Account Dr. (with discounted amount)
  - Discount Allowed Account Dr. (with the discount deducted by the bank)
  - To Bills Receivable Account

2. Promissory Note:

At the Time of Issuing the Note:
- Maker's Entry:
  - Payee's Account Dr.
  - To Bills Payable Account
On Payment:
- Maker's Entry:
  - Bills Payable Account Dr.
  - To Cash/Bank Account
For the Payee:
- When the note is received, the payee debits Bills Receivable Account and credits the Maker’s Account. Upon payment, the Bills Receivable Account is credited, and Cash/Bank Account is debited.

Dishonor of Bill or Promissory Note

If the bill or promissory note is dishonored (i.e., payment is not made), the following entries are passed:
- For Drawer:
  - Debtor’s Account Dr.
  - To Bills Receivable Account
- For Drawee:
  - Bills Payable Account Dr.
  - To Creditor’s Account
Additional entries may be required for noting charges if the bill is dishonored.

These instruments play a crucial role in credit transactions by allowing parties to formalize and manage deferred payments. They also ensure legal recourse in the case of default.

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